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A “sell-off” is easy to see when it happens. A high number of securities (e.g. stocks and bonds) are sold in rapid succession – perhaps hours, days or weeks. The spiral downwards often goes faster as investors feel pressure to sell due to everyone else doing so. The overall psychology of the marketplace turns negative, and fewer shares are purchased since their prices are seen as too high for what investors are prepared to pay.
Many sell-offs have occurred in recent history – with the 2020 COVID-19 stock market crash the most recent. There are also many factors that can trigger them. As financial planners, we often face questions about how investors should handle these kinds of situations. Below, our team in Padiham, Burnley, Lancashire offers some thoughts on this important topic.
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Why sell-offs happen
An illustration of herd mentality can help us understand why some sell-offs happen. Imagine a huge crowd of people in a stadium – numbering tens of thousands. Suppose, then, that in one corner of the crowd, someone with a megaphone shouts “fire” and people immediately around them start to panic and flee. People further out in the crowd start to notice the commotion, and also begin running away – perhaps without fully understanding what is happening. Without careful crowd control, these situations can turn deadly.
A similar dynamic can occur in stock markets where millions of investors are trying to grow their wealth through stock holdings. Within that crowd are prominent people (like the “megaphone” holders in the example) who many of the others listen to, to guide their own investment choices. This could be someone like Warren Buffet, Elon Musk or Michael Burry, or institutional bodies like Ark Invest. If such people shout “fire” about the stock market – perhaps because they think a crash is imminent – then a widespread sell-off could occur.
There are other reasons, however, behind why sell-offs happen that are not simply rooted in herd mentality. These include:
- Unforeseen events. In extreme cases, a “black swan” event can lead to extremely bad consequences. By nature, they are impossible to predict – even if many argue that they were obvious in hindsight. A famous example is the 2008 Financial Crisis.
- Movements in the economy. Many aspects of the economy can lead to a widespread sell-off in stock markets. Currency and commodity fluctuations, for instance, can lead investors to sell quickly to try and protect their portfolios.
- Analytical indicators. Many studies are frequently released by stock market analysts to try and help investors guess what will happen (e.g. the Moving Average Convergence Divergence (MACD)). If these point to a negative future trend and enough investors believe them, it can lead to a sell-off.
What to do in a stock market sell-off
Even for seasoned investors who have weathered many storms before, a sell-off is a difficult emotional experience. It is never easy to watch your portfolio fall rapidly as stock valuations plummet. Yet the most important thing to remember is that, until you sell, you have not “lost” anything. Your losses are “nominal” – existing in name only, as numbers on a screen – unless you sell, at which point they become crystallised.
As such, investors should always be careful not to act impulsively during a sell-off. Doing so could undo years of investment growth. Bear in mind that, in the long run, stock markets tend to recover and even surpass their “pre-sell-off” value. In other words, waiting patiently could lead you to a better financial position in the future. For investors who follow a “pound-cost averaging” approach, moreover, continuing to invest during a bear market could open up opportunities for you to buy “cheap stocks” which later rise in value.
Given the high stakes involved, however, it is still easy to act rashly with investment decisions even with this knowledge armed at hand. This is why a financial adviser can be so valuable for investors. He/she can provide a sounding board for your concerns during a sell-off, reminding you of the time-honoured principles of investing which can help see you through these difficult events. Your financial adviser can also remind you that you accepted the reality that sell-offs would likely occur during your chosen period of investing, and that you created a strategy to help mitigate the damage (e.g. through appropriate diversification of your assets). Finally, your financial adviser can bring their considerable experience, knowledge and credentials to the table when looking at your portfolio within the context of a sell-off. So, if any of your investments do, in fact, need changing in light of the new market conditions, they can guide you on the best way to do so – mitigating unnecessary costs along the way.
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938